Why Do Directors Get Into Trouble and How to Avoid It In the First Place

By Terrance S. Carter

A. Introduction

Many leaders in the community are happy to serve as volunteer directors, governors, board members or trustees (broadly referred to here as “Directors”) on the boards of non-profit organizations (“NPOs”) and charities, most of which are organized as not-for-profit corporations. Such volunteerism is laudable and to be encouraged. However, many individuals take on these positions unaware of the duties imposed upon them and the problems they might face as Directors. The purpose of this article is to provide some practical considerations to assist Directors in understanding their duties, how they might get into trouble, and what they can do to avoid it in the first place.

B. Understanding Director’s Duties

1. General Fiduciary Duty with Incorporated Charities and NPOs
Directors of NPOs and charities have a general fiduciary duty to act honestly and in good faith with a view to the best interests of the corporation. In practical terms this general fiduciary duty, requires that Directors, (1) be familiar with all aspects of the corporation, i.e., read all relevant documentation and attend board meetings; (2) manage or supervise the management of the corporation; (3) comply with applicable governing legislation, e.g., Canada Not-for-profit Corporations Act (“CNCA”), and the corporation’s articles, letters patent, or by-laws; (4) ensure the purposes of the corporation are properly carried out, and that activities fit within those purposes; (5) maintain confidentiality of information obtained in the course of their duties; (6) declare and avoid any conflicts of interest; and (7) remain Directors, where personal circumstances permit, even though the corporation may be facing financial or legal difficulties.

2. Higher Fiduciary Duty Involving Charitable Property
With regard to charitable property held by a charity or funds raised by an NPO for a charitable cause, Directors will also be “high order” fiduciaries. This higher fiduciary duty gives rise to additional duties, including: ensuring that charitable property is used in accordance with the applicable charitable purposes; ensuring that charitable property is invested as a prudent investor would in accordance with applicable provincial legislation; acting without receiving any direct or indirect remuneration unless authorized by court order; as well as keeping detailed records of the charitable property under management.

3. Standard of Care
Directors of corporations have a duty to act in accordance with a standard of care in meeting their fiduciary duties. However, this standard of care varies depending on the type of corporation and its operating jurisdiction. For Directors of not-for-profits corporations under the CNCA, for example, the legislated standard is an objective standard of what a “reasonably prudent person” would do in the circumstances. However, where corporate legislation is silent, a subjective standard of care will generally apply. This subjective standard of care dictates that a Director is expected to act with the degree of skill and care that could be reasonably expected from a person with similar knowledge and experience.

It is important to remember that the non-profit or charitable character of the work being done by the corporation is no excuse for Directors failing to meet their statutory duties, nor is ignorance of the law a defence.

C. Situations That Can Get Directors Into Trouble and What to Do

Most situations that get Directors into trouble are generally caused by a misunderstanding of their legal duties as described above:

1. Poor documentation: When Directors are not familiar with the organizational documentation of the corporation or fail to ensure that corporation is operated in accordance with those documents, they run the risk of breaching their fiduciary duty to the corporation.

What to do?
A Director should review all of the corporate documentation of the organization before agreeing to be elected onto the board and ensure that the corporation is consistently being operated in accordance with those documents. Where an inconsistency is found that cannot be resolved, then legal advice should be sought.

2. Lack of engagement: When Directors fail to attend board meetings or fail to read relevant materials before voting, they run the risk of breaching their fiduciary duty of good faith.

What to do? A Director should accept a position on a board only when the Director is prepared to be present at board meetings and do the necessary homework to be conversant with the issues concerning which the board will need to be making decisions on.

3. Failing to speak up: When Directors fail to voice their concern or disagreement on an issue or are pressured to vote in a particular way, they run the risk of breaching their fiduciary duty and potentially being exposed to personal liability.

What to do? A Director should be mindful of strong personalities on the board who may think that their opinion reflects the collective opinion of the board because they hear no dissent, or who may ostracize individuals who disagree with their views on a particular matter. If a Director disagrees with a decision that the board is making, the Director needs to record his or her dissent, preferably with a reason recorded in the minutes. Otherwise, the Director will be deemed to have concurred with the board’s decision, subject to the legislation governing the corporation.

4. Failure to manage or provide adequate supervision over the managers of the corporation: When Directors fail to properly manage or supervise the management of the corporation, they run the risk of breaching their fiduciary duty by assuming they are not responsible for decisions made by management.

What to do? Directors are the guiding minds of the corporation and, therefore, the ultimate repository of all authority. At the end of the day, the “buck stops” with the board. As a result, Directors must always be able to demonstrate that they are exercising sufficient supervision to appropriately monitor the authority delegated to managers in undertaking the programs and activities of the corporation that the board has authorized.

5. Failure to address conflicts of interest: When Directors fail to put the interests of the corporation ahead of their own, they run the risk of breaching their fiduciary duty of honesty and loyalty. Conflicts of interest can take a wide variety of forms, such as receiving remuneration beyond reasonable reimbursement for expenses, drawing some other economic advantages through related businesses, or the use of material non-public information for personal gain.

What to do? Conflicts of interest are a complicated area of the law where legal advice should be sought. However, in general terms, Directors of an NPO need to identify and disclose any conflicts of interest in accordance with the by-laws and policies of the corporation and not vote. For a charitable corporation, the Director may also need to resign from the board if the conflict situation continues.

6. Failure to comply with statutory obligations: Directors of NPOs and charities are also required to comply with statutory obligations, failing which they can often be held personally liable on a joint and several basis with other board members. For example, directors can be personally liable for failing to remit source deductions from employees under the Income Tax Act (Canada).

What to do? Directors should be familiar with general laws that apply to their activities, such as the Income Tax Act (Canada), applicable employment and health and safety legislation, privacy legislation, etc. Directors should ensure that these potential liabilities are managed appropriately, especially with regard to those that may have personal application, e.g., source deductions on employee compensation.

7. Failure to maintain confidentiality: When Directors fail to maintain confidentiality with regard to any information arising from a board meeting or any sensitive or personal information from the operation of the corporation, including employee, volunteer or donor information, they run the risk of breaching their fiduciary duty of confidentiality.

What to do? Directors must not disclose any information obtained in the course of their duties, including the discussions at board meetings. A robust confidentiality policy should be prepared with the assistance of legal counsel. Directors must also become familiar with the requirements of applicable privacy legislation for the collection, management and protection of personal information.

8. Unnecessary litigation: When Directors are unable to rise above personal disputes among themselves or inappropriately use their position of power to influence board or membership decisions that give rise to unnecessary litigation, they run the risk of breaching their fiduciary duty to act in good faith with loyalty and ensure that funds of the corporation are not misused.

What to do?
When a situation comes up that may result in litigation with another party, whether it be an employee, a volunteer, a member, or even another Director, the Directors should ask themselves whether the situation can be avoided, and if not, whether the resulting cost of litigation can be justified as a necessary means to achieve the applicable purposes of the corporation.

9. Failure to comply with restricted funds: When Directors of an NPO or a charity which holds charitable funds for a particular restricted purpose do not ensure that the applicable restrictions are being complied with, such as a scholarship fund or a cause marketing program, they run the risk of being in breach of their high fiduciary duty to manage charitable property, as well as the possibly of being in breach of trust.

What to do? Directors should determine if there are any restricted funds being held by the corporation and then establish a protocol in order to ensure that the applicable restrictions are being fully complied with and that there is ongoing reporting to the board.

D. Concluding Comment

Being a Director can be a rewarding experience. However, in order to avoid getting into trouble, it is important for Directors to keep their focus on understanding and complying with their legal duties and avoiding situations that could result in a conflict with those duties.